audit legal liabilities
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7/23/2019 Audit Legal Liabilities
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©2012 Prentice Hall Business Publishing,
Auditing 14/e,
Arens/Elder/Beasley 5
-
1
Legal Liability
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©2012 Prentice Hall Business Publishing,
Auditing 14/e,
Arens/Elder/Beasley 5
-
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Learning Objective 1
Understand the
litigious environment
inwhich CPAs
practice.
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©2012 Prentice Hall Business Publishing,
Auditing 14/e,
Arens/Elder/Beasley 5
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3
Changed Legal Environment
Audit professionals have acontractual responsibility with clients.
Auditors are liable for negligence.
The number of lawsuits and sizes ofawards remain high.
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©2012 Prentice Hall Business Publishing,
Auditing 14/e,
Arens/Elder/Beasley 5
-
4
Changed Legal Environment
Growing awareness by financial statementusers
Increased consciousness of the SEC
Complexity in business drives complexity inauditing and accounting functions
Litigious society
Major contributors:
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©2012 Prentice Hall Business Publishing,
Auditing 14/e,
Arens/Elder/Beasley 5
-
5
Changed Legal Environment
Large civil court judgments against CPA firms
Willingness of CPA firms to settle out of court
Judges’ and jurors’ difficulty in understanding
technical accounting and auditing matters
Major contributors (cont.):
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©2012 Prentice Hall Business Publishing,
Auditing 14/e,
Arens/Elder/Beasley 5
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Learning Objective 2
Explain why the failure of financial
statement
users to
differentiate among
business failure,
audit failure
, and auditrisk
has
resulted
in lawsuits.
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Business Failure, Audit Failure,and Audit Risk
Business failure
A business is unable to meet itsobligations or investor expectations dueto economic or business conditions.
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Business Failure, Audit Failure,and Audit Risk
Audit failure
Auditor issues an incorrect opinion froma failure to follow GAAS.
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Business Failure, Audit Failure,and Audit Risk
Audit risk
The risk that the auditor fails to find amaterial misstatement and issues anunqualified opinion.
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Learning Objective 3
Use the primary legal concepts
and terms concerning accountants’
liability as a basis for studying
legal liability of auditors.
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Prudent person concept
Liability for the acts of others
Lack of privileged communication
Legal Concepts AffectingLiability
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Legal Terms AffectingCPAs’ Liability
Terms related to negligence and fraud:Ordinary negligence
Gross negligence
Constructive fraud
Fraud
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Legal Terms AffectingCPAs’ Liability
Breach of
contract
Contract Law
Third party
beneficiary
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Legal Terms AffectingCPAs’ Liability
Other terms:
Common law
Joint and several liability
Statutory law
Separate and proportionate liability
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Learning Objective 4
Describe accountants’ liability to
clients and related defenses.
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Four Major Sources of Auditors’Legal Liability
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Liability to Clients
The most common source of lawsuitsagainst CPAs is from clients.
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Auditor’s Defenses AgainstClient Suits
Lack of duty to perform
Nonnegligent performance
Contributory negligence
Absence of causal connection
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Learning Objective 5
Describe accountants’ liability to
third parties under common law
and related defenses.
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Liability to Third Parties UnderCommon Law
Ultramares doctrine Foreseen
users
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Foreseen Users
Credit alliance
Restatement of torts
Foreseeable user
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Auditor Defenses AgainstThird-Party Suits
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Learning Objective 6
Describe accountants’ civil liability
under the federal securities laws
and related defenses.
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Securities Act of 1933
The Securities Act imposes anunusual burden on the auditor.
Section 11 of the 1933 act defines therights of third parties and auditors.
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Securities Exchange Act of 1934
Auditor liability under this act oftencenters on the audited financial statements
issued in annual reports
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Rule 10b-5 of the SecuritiesExchange Act of 1934
Section 10 and rule 10b-5 are often calledthe antifraud provisions of the 1934 act.
“Scienter” states that auditors must havethe knowledge and intent to deceive in
order to be liable for violation ofRule 10b-5.
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SEC Sanctions
SEC can sanction or suspend practitioners.
SEC has temporarily suspended a number of
individual CPAs from auditing SEC clients.
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Foreign CorruptPractices Act of 1977
Bribing a foreign official for the purposeof exerting business related influence
is illegal.
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Sarbanes-Oxley Act of 2002
CEO and CFO are required to certifyfinancial statements filed with the SEC.
Management must report on theeffectiveness of internal controls overfinancial reporting.
Auditors must opine on internal controlsover financial reporting.
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Learning Objective 7
Specify what constitutes criminal
liability for accountants.
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Criminal Liability
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Sarbanes-Oxley Act
This act makes it a felony to destroyor create documents to impede or
obstruct a federal investigation.
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Auditor Defenses –1933 & 1934 Acts
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Learning Objective 8
Describe what the profession and
the individual CPA can do and
what is being done to reducethe threat of litigation.
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The Profession’s Responseto Legal Liability
Research in auditing
Standard and rule setting
Set requirements to protect auditors
Establish peer review requirements
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The Profession’s Responseto Legal Liability
Oppose lawsuits
Education of users
Sanction members for improper conductand performance
Lobby for changes in laws
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Protecting Individual CPAsfrom Legal Liability
FollowProfessional
Standards
Honest Clients
MaintainIndependence
QualifiedPersonnel
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Protecting Individual CPAsfrom Legal Liability
Understand the client’s business
Perform quality audits
Document the work properly
Obtain an engagement and a representation letter
Maintain confidential relations
d d l
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Protecting Individual CPAsfrom Legal Liability
Carry adequate insurance
Seek legal counsel
Choose a form of organization with limited liability
Exercise professional skepticism
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